David Kuo talks with Sarah Pennells about ethical investing.
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David:
This is Money Talk, the weekly podcast from the Motley Fool. I'm David Kuo, and as a huge fan of The Good Life, I've always had a soft spot for Felicity Kendall's green leanings, but sadly I, like most people, have been motivated more by greed than green when it comes to money matters, but here to show me the error of my ways is one of my favourite broadcasters, Sarah Pennells, who has just written a book called "Green Money: How to Save and Invest Ethically". Welcome to The Motley Fool, Sarah.
Sarah:
I didn't realise I had such a hard task of showing you the error of your ways this afternoon, I thought I was going to chat about my book for a few minutes!
David:
I think I can assure you, you have a very hard task to show me the error of my ways, but hopefully by the end of this podcast I may just swap my John Russell brogues for rope sandals, and my Ralph Lauren shirt for a hand-knitted jumper. But, before we can do that, you have to explain to me -- what exactly is “ethical investing”, and how does ethical investing differ from proper investing?
Sarah:
Well, first of all I'll take you to task on the fact that you call the other investing “proper investing”, but maybe we can have that fight later. Ethical investing, in its simplest terms, means looking at companies that you put your money into, and working out whether or not you want to invest in them, based on what you believe in, so for some people, and some funds, it will mean not putting money into companies that make armaments, for others it might mean not putting money into mining companies or airlines. I think one of the things that's great about ethical investing, but also really really confusing, is the fact it does mean different things to different people, and different things to the financial companies offering these products.
David:
So what you're saying is, there are degrees of being ethical, aren't there?
Sarah:
I think if you look at how we live our lives, there are some people who are obviously very very committed to living in an ethical way, but most people, I mean our lives involve huge amounts of compromise, and for companies that's true, but more so, and I think if you go into ethical investing or any kind of ethical money thinking, “I'm only going to support ethical companies”, you're going to be really disappointed, because probably there are half a dozen, 20 companies that you would want to put your money into, and for most people that's just far too risky.
So I think the first thing you have to get your head round is that you're going to have to compromise, and be a bit pragmatic, because for most of us, we might like the idea of putting our money into certain kinds of companies, and not supporting other areas, but I don't think we'd actually feel prepared to take the risks that go along with it.
But having said that, I think if you can work out firstly what your ethics are, what your ideas are, what's important to you and what isn't, and where you can compromise, then I think that actually the fact there is all this choice is really good thing. If we had one or two funds that had a kind of ethical kitemark, I think that would be a really bad state of affairs, because there'd be no choice, there'd be kind of like a set of criteria that ethical funds had to comply by, well on one level you might think that's really good, but what if to me, a company that tests its products on animals, I don't have a problem with that, what if I'm a researcher working at a pharmaceutical company, and I want to get a cure for a particular disease, and the only way I think that can be done is by testing on animals, to me investing in a fund that discounts those companies isn't important, but to somebody else that could be the most important thing, that they do avoid companies that invest in animal testing, companies that are involved in animal testing. So I think the fact there is broad arena is a good thing, but it is confusing if you don't understand actually that ethical can mean something and nothing almost.
David:
So how did this ethical investing malarkey first start then?
Sarah:
Well, this malarkey started in about the 1800s, and it's with the religious movement, the sort of Quaker movement, for a start. But it really stayed limited largely to kind of church investing for quite a long time, and it was really only in the 1970s that the idea was to actually start a fund in the UK. It has to be said that America had a fund actually I think from the early 1970s, which is still going strong today, but this chap called Charles Jacob actually wanted to start the first ethical fund, and he tried to get permission to start an ethical fund, and the government turned him down twice, saying that you couldn't try and make profit while also taking ethics into account, and actually this month is the 25th anniversary of the first ethical fund, which was the stewardship fund set up by Friends Provident. At the time I think people in the City, the wise old sages in the City, said, "This fund will have no more than £2 million tops." Now the Stewardship group of funds has £3 billion invested, so maybe they weren't as clever as they thought they were!
David:
So what about in total then? – how much money is being invested in total, in ethical companies?
Sarah:
Well, in total the figure is about between £8 and £9 billion. When I wrote the book, it was about £9 billion, when I started researching, obviously the market went down!
David:
And your funds as well, yeah?
Sarah:
Indeed, so what's interesting is that, even over the last say 18 months, when there has been a fair amount of turmoil in the stock market, money put into ethical funds has stuck there more than money put into what you would might term "proper investing".
David:
Right, OK.
Sarah:
So a lot of investors who are just putting that money into any old fund, they've been more keen to take their money out when the going's got tough, whereas those who have invested in ethical funds, for whatever reason, have felt more inclined to stick with it.
David:
But as far as people are concerned, they would be having questions like, “How does ethical investing differ from things like sustainable investing, or green investing?” – I mean, it's a whole conundrum there, isn't it, really?
Sarah:
I think this is one of the areas where ethical investing doesn't do itself any favours, because the terminology and jargon is completely baffling, and I think ethical investing in one way is actually the easiest to define, because it does normally mean making decisions to either exclude some companies, or to actively target others, depending on what the criteria of that fund are. Now, it does mean that within that, funds can have very different ideas about what they think is ethical, but the concept is fairly straightforward, but when it comes to things like green or climate change or sustainable or socially responsible, for a start companies use these terms interchangeably, indeed as do individuals.
Green funds to tend to say focus on environmental companies, so they might be ones involved in producing water treatment or energy efficiency measures, or ways of producing energy that doesn't rely on fossil fuels, but some companies that produce climate change funds, it can mean that they just won't invest in the very worst, as in the ones that produce the most pollution or the most carbon dioxide, and actually that can mean, I think there's one climate change fund that, when it launched, invested in Porsche – well Porsche, apparently the reason that Porsche got into this fund at the time was that apparently its manufacturing methods were not the worst, they were sort of better than average, but to most people, I think investing in a fund that targets climate change wouldn't necessarily mean investing in a manufacturer of gas guzzling cars that are the luxury end of the market.
So I think you do have to be very careful, and look at how companies use these terms, because they can mean kind of what the company wants them to.
David:
But your point there, I mean you touched on something about water treatment, now that interests me quite a lot, because if you were investing in say a water company, one of the water utility companies, and you think, “That is a good ethical sustainable company, that's something I want to be involved in”, only to find that that company supplies water to a nuclear power plant, so does that then sort of change your idea about whether or not that company is ethical any more?
Sarah:
That's something that some of the funds have addressed, and what a lot of them have is, they have a cut-off point above which they won't invest in companies, so for instance, there was an example that one of the green funds initially found that this company that was treating water failed its criteria, because it did supply ultra pure water for the nuclear power industry, but actually what they did was, they realised that it actually made up only something like 2% of what they company actually produced, and that the time spent analysing this was, it really wasn't worth it.
So what they said was, OK, we're going to have a 10% cut-off point, so if more than 10% of the company's turnover comes from areas that are excluded according to our criteria, we won't invest; if it's below 10%, then we will. Other funds will take a 5%, or they'll just say, "OK, if it supplies water for nuclear plants, we're not going to touch it", but that's one of the good things in a way, because you can choose a fund, if you want to have a bit of flexibility and think, "Well actually, a lot of what this company does is really good, but it does supply some water for nuclear power, but it's really the minority of what it does – I think I'm happy with that."
David:
So what you're saying is, I can be just 90% ethical then?
Sarah:
To me, having some money in my pension fund in an ethical company, or having it in ethical funds, is important, but there's no way I'd look at myself and think, "Well, I'm an ethical person", I think all of our lives involve huge amounts of compromise, you might recycle but you might drive when you know you could walk.
One of the good things about ethical money is that, if you take a kind of pragmatic view, and think, "OK, life's not perfect, we're not perfect – what's important to me? What do I not want my money to go into? What do I want my money to be used for?" Then there's a fund or several funds out there that you can find, there are some really good funds. I have to say there are some that are a bit bandwaggony, the "me toos", that I think probably just want to have something under their branding that tips a nod towards the fact that they do something ethical. But there is enough choice out there, but I think if you go into this thinking, "I don't want my money to go into any company that in any way is doing anything bad", well you're going to come unstuck, and I think you're going to become quite disappointed.
David:
So is there an easy way that investors can find out whether or not their fund or the company is ethical to such a degree that they are happy to invest in?
Sarah:
When I was writing the book, I found it really hard to get information for consumers, that was consumer-friendly about these funds. There is a site that's being launched at the end of the month called yourethicalmoney.org, which is produced by this research company called Iris. Now, they spend a lot of their time basically screening companies that funds want to invest in to find out what they do, and what they have on their site and what they're going to be having on the new site is a list of all the ethical funds, what their criteria is, what their cut-off point is, and how what they do matches up to what's on the tin.
So there are places you can get information from, but actually some of the companies' own websites, some of the fund providers' own websites are very good, I mean Henderson is one that, it lists every single company its funds invest in, and what they do. If you're prepared to ask questions, and do a little bit of digging under the bonnet, then you can find the answers, but what you can't do, because I think it would be very disappointing if you do it, is think, "I want to invest ethically, I'll choose that fund", because probably you'll find there are other companies in there that you really don't want your money to go into.
David:
But in your view, if you are investing in an ethical fund, is that generally a good investment? Does it give better returns than just investing in either the wider market, or in my case, sin shares?
Sarah:
It's interesting, because I think a number of years ago there was always this debate saying that you can't profit from your principles, etc, but I think that is changing, and there's been research by the consultancy, Mercers, and also by the Investment Management Association, both of which show that, although for the shorter term there is going to be much more volatility, I mean like at the moment I think ethical funds generally aren't doing as well as what you call "proper investing".
David:
You're not going to let me live this down, are you?
Sarah:
I'll try not to! – but over the longer term, there isn't actually any difference, and in some areas there is some thinking that, for some funds that, particularly targeting climate change areas, so basically companies that are learning to produce more with less, that are less wasteful, less environmentally-polluting, they're actually going to do better, because there's less of an investing risk that something awful will come up. There's a lot of work being done now from big companies on how climate change is going to affect them, things like chocolate producers looking at how climate change is going to affect cocoa. The idea is that companies that are aware of this, they've thought of risk long term, and one of the issues with companies at the moment is that they're great at producing short term returns, but oops! – five years down the road, there's suddenly something they never thought of, and the whole model isn't sustainable any more.
So I think there is something in that, I certainly don't think that you should go into an ethical fund thinking, "Well, I'm doing this just for the love, and not making any money", but if you want to match pound for pound what you're getting over the short and long term, you probably won't do that.
David:
But do you think it actually makes a difference? – because you mentioned right at the top of the podcast that about £9 billion or more or less is being invested in ethical companies, ethical funds, but the entire stock market is worth over £1 trillion, so it really is a drop in the ocean compared to the market as a whole. So how can you or I make any difference to what is going on in the environment by putting our money into these ethical funds?
Sarah:
Well, there is one type of fund which I think definitely is making a difference, and sorry for the jargon, but these are called "engagement funds", so these aren't ones that necessarily will strike out certain companies, although some of them do, because they admit they are kind of ethically engaging funds, but what they do is they actually talk to the companies, they use their vote at the annual general meeting, and there have been some very specific examples of changes that they've made in the behaviour, and their thinking is, "Well look – we're not going to set up a fund where we say we won't invest in certain companies, what we're going to do is put our money in companies, but try and change them".
They can only change them where there's a business case, so they can't invest in a tobacco company and say, "You shouldn't be selling cigarettes", but they could invest in a tobacco company and, if there was a danger or an idea that it was going to new markets, and maybe exploiting children, teenagers, then they could say, "Well actually, there's a risk here, because if news gets out of this, it's going to damage your reputation, that's going to damage shareholder value", so in that way they can alter their behaviour, and there have been a number of examples of where it actually has been pressure from the shareholders from these ethical engaging funds that has changed the company's behaviour, not the government and not anything else.
David:
Another group of companies that you talked about earlier on was the pharmaceutical industry. Now, a lot of people will say, "These industries are perhaps not as ethical as we would like, simply because of the amount of animal testing that goes on", but on the other hand pharmaceutical industries prolong people's lives, they ease people's suffering, for instance when they are ill, so pharmaceutical industries, in your opinion are they ethical or are they not ethical? And should they be included in a fund? If it wasn't included in a fund, would you then say, "I don't really want to have anything to do with that fund"?
Sarah:
It's not for me to say whether it's ethical or not, it's down to whether, in your ethics, is it important to you that a company doesn't test products on animals? – and is it important that it's all products, or medical products only, or cosmetics only, and that's actually part of the debate, the question that you have to have, and I think that's the thing that's missing at the moment from some people when they make the decision to go into ethical investment, that they make the decision, and they think that's the hard work over, whereas actually, the bad news is it's just the beginning, because the really important bit, apart from obviously looking at the individual funds and looking at the charges and things like that, the really really important bit is to work out, "What do I not want to compromise on, what am I prepared to compromise on, and also how much risk am I going take?", and if you don't ask yourself those questions, you are going to become unstuck, and you're going to be really disappointed, because, when I wrote the book, I talked to a lot of people who had either invested ethically, who'd thought about it and not done it, some who'd never thought about it, and the one thought that came back time and again from those who'd either done it or thought about it was, basically, "I wanted to invest ethically, and now I looked at what was in the fund, and they had an airline, or they had Tesco, and they're not ethical", and you might not think Tesco's is ethical, but the reason it makes it into a lot of funds is that, at the end of the day, it's a supermarket, it's not making armaments, it's not …
David:
But it's selling cigarettes and it's selling alcohol?
Sarah:
Well, in that case, retailers often make it into funds that don't invest in tobacco companies or alcohol-producing companies, because in terms of their turnover, the amount of money they get from cigarettes and alcohol is actually quite small, and some companies won't invest in alcohol-producing companies, but they will invest in retailers, and they will say that, retailers don't come under this criteria. But that's what you've got to work out, if you're going to exclude every company that sells cigarettes and alcohol, then you're going to exclude quite a few. Now that might to you be a price worth paying, but it might not be to the next person, it might not be to me, but that's actually where I think people have to spend a bit of time.
There will be a fund out there that will line up with most of their ideas. The problem is, it might not be one that it's suitable to put all your money into. I think the risk thing is really really important, and I think maybe the last couple of years have shown us just how important risk is, and you have to think, "Am I happy to exclude quite a few big companies? Do I not mind that the hopefully stabilising effect that having those companies in my fund will have, might not be there to the same extent?", and if you are, fine, but you've got to actually realise that there is a trade off, the less able you are to compromise, the more risk you may end up taking.
David:
But what about those people who are investing for their retirement, for their pensions, and they are part of this defined contributions scheme within a company? – how do they try and reconcile it to themselves, that they are indirectly investing in things that really are against their own principles?
Sarah:
I think this is a real problem, this is an area that is a real disappointment, that more hasn't happened, because basically, if you're in a scheme where, a defined contributions scheme say, you've got the choice of a whole load of funds to invest in, but let's face it, over 90% of people put their money in the default fund anyway; a lot of companies' pension just provide basically one fund, so there might be 75 different funds to put your money in, one of which will be ethical, now if you're lucky it could be a really well run ethical fund, but it might be a complete hound, and you probably won't know that, because unless you've got enough information, and you know how to do the research, and I think that actually is a real problem, that there are probably a lot of people who might want to invest, some of them, they might not even want to invest all of it, but might want to invest their money ethically, but they're faced with a choice of one rubbish fund or sometimes they don't even realise it's an ethical fund, because unless it's branded that way, the title of the fund may not have the word ethical in, and they might not recognise it, and I think that's a real problem.
The other issue is, if you're in a final salary scheme, then although there are a couple of pension funds that will take a more environmentally-friendly view, it's actually very difficult for them to start excluding companies, so they can't strictly be ethical, so in which case well you think, "Do I take my employer's money and invest in whatever they decide to invest in, or do I take a decision that it's going to leave me financially far worse off, and start my own pension?" I mean I actually say I think you should take the employer's money, because I think the consequences of not doing so are so financially serious, some people I know will disagree with me, but obviously you have to do what you think is best, but I would say, think really carefully before you turn away your employer's money, because most people are going to be retiring on enough to buy fish and chips, not to go cruising around the Med.
David:
What do you think the future is for ethical investing? – do you think more and more people will start to warm to the idea of ethical investing, and start wearing those rope sandals and start braiding beads in their hair?
Sarah:
I won't feel my work is done until I see you in precisely that outfit, David! I think this day may come sooner than I think. Actually, I do think it's a really exciting time for ethical investment, and in the broader sense, and I include green and climate change investment in that, partly because, things like for the Co-Op Bank has said it's seen a 120% increase in people opening current accounts since last summer, I think a lot of us are now thinking about, “Well actually, what was the bank doing with my money? – if they can't do their own sums, how on earth can they look after my accounts?”
There has been also a couple of other of these ethical banks have seen a real increase in the number of people wanting to open savings accounts – "Why would I want to have my savings account supporting things that I don't even know where the money's going?", so I think it's a really exciting time. I actually think there's possibly going to be more of a shift away from the strictly ethical funds that screen out and actively invest in, and more of a move towards those that engage, because although you have to be prepared to compromise here, I think the argument's quite compelling in that, if you can get a massive company to shift what it does, you're actually making a much bigger difference than just by saying, "I'm not going to put my money in you", because what influence do you have over what they do then?
And I also think that, whatever people think about climate change, I think there's a lot of evidence that our environment is going through a fairly turbulent time, and whether you think it's man-made or whatever, there are some companies that are much more aware of the risks, and how they have to change their practices just to cope with that, and I think again that's feeding into this whole issue of, energy efficiency, water treatment, recycling, that whatever does happen in the future, I think there are some companies that have thought about this that will be better placed, and they generally are the ones that are in a lot of these climate change funds.
David:
But how much of that is actually down to marketing, from the point of view of the company itself, where they say, "We're going to bring in Fairtrade coffee, or Fairtrade bananas, because our consumers want it, so therefore we're going to have this little stand in the corner here with the bananas that aren't particularly straight, and we'll call them Fairtrade bananas, and we'll sell them to consumers, because they want it." I mean, how much of it is actually marketing-led?
Sarah:
There is definitely some, and I think there are a number of companies that have launched an ethical or green fund, because they want to have one. They don't want you to go to somebody else.
David:
They don't want to miss out, do they?
Sarah:
But actually, what often happens is that they don't necessarily look at changing their criteria, they don't really refresh the fund, because they don't really care whether it's particularly relevant for today or tomorrow, so they'll have one set of fund values that has stayed the same, they maybe will put a fund manager who's not got a huge amount of experience there, they won't even necessarily actively market it, they'll just having it sitting there, so if somebody wants it, they can sell it.
There are enough people in the ethical financial advice world who know who these companies are, and they know what these funds are, so if you want to find the information, you can, but it's certainly true that, in the same way, I was talking to one of the fund managers, and he was saying, "When we look at whether a company's being environmentally-friendly or energy-efficient, it's not about them recycling plastic cups in their office – we're not that stupid", and yes, they're getting much better at trying to tell us how environmentally-friendly they are, but we have to stay one step ahead and actually really drill down into it, because there's no point, he said, "Anybody can chuck their plastic cups into a bin, but we've got to do something that's meaningful", so I think that actually the people who are making the decisions, they're not naïve, I think they know that they could be being played as well, and I think that actually there are enough people out there who are really trying to make a difference, while understanding that you can't just invest in an ethical company, because realistically these are funds that have to be a certain size to sustain themselves, so they have to have quite broad appeal.
David:
So you think there is a future for this then?
Sarah:
I do, I don't think that ethical investment will attract more than about £2 million though obviously … no! No, I think it's actually got a very positive future.
David:
I think you become more ethical as you grow older, I think when I was younger …
Sarah:
Does that make you very very very old?
David:
I think that was uncalled for! I think, as you get older, you do become slightly more ethical, because the pace of life begins to slow down a bit, and you see things that are going on around you. I'm not entirely convinced that I will get rid of all my unethical investments, so maybe perhaps I won't trade my brogues for rope sandals, but I may meet you half way, Sarah – I'll wear a pair of loafers, how's that?
Sarah:
Kind of perfect!
David:
Thank you very much for coming in today, Sarah, and as you know I end each podcast with a quote, and I found one day from a guy called Paul McCreedy. Now he said, "Your grandchildren will likely find it incredible, or even sinful, that you burned up a gallon of gasoline to fetch a packet of cigarettes" …
Sarah:
Very good.
David:
… and I think what ethical investing is all about is to try and waken people up to the idea that there is an alternative out there, and I know I pulled your leg on a number of occasions about ethical investing, but I am really quite an ethical person, so your book once again is called what, Sarah?
Sarah:
It's called "Green Money: How to Save and Invest Ethically".
David:
OK, I hope it does well, and we'll be putting a copy of the link to that book on our website ourselves.
Sarah:
Great, thank you very much.
David:
This has been MoneyTalk, now if you want to tell me what you thought about today's show, you can post it on MoneyTalk blog, which you can find on our home page at fool.co.uk. If you want to suggest a topic for future shows in private to me, you can email me at moneytalk@fool.co.uk. Either way, it will get to me. Thank you Sarah, for coming in today, and may all your investments be green and profitable.
Sarah:
I wouldn't expect anything less.
David:
Thank you.
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